For businesses to be recognized and acknowledged by skeptical potential customers, providing sustainability reports or ESG reports is an absolute requirement. Many companies fail to secure their customers’ trust for ethical and moral reasons. Hence, reports discussing the businesses’ environmental, social, & governance impact are of utmost importance. So the million-dollar question is, what is it?
What is the ESG Report?
The ESG is an acronym for Environmental, Social, and Governance. In essence, the ESG aims to publish an organization’s sustainability efforts. The report should include comprehensive data on a company’s operations and their effects on the three pillars discussed.
A Bitcoin example
As you may know, Bitcoins are created through “mining.” To mine new coins, miners have to build mining factories (bitcoin farms). These factories house supercomputers with robust cooling systems. Computers are used to solve complex mathematical puzzles and are rewarded with a new coin.
Due to the complex nature of the calculations, the computing power required is tremendous. As such, these facilities tend to require immense energy, almost the same as a small city or town!
In fact, according to Sunbird, to mine 3% of all the available Bitcoins, a farm in Dalian, China, has an estimated monthly electrical bill of $1,170,000.
And it gets better; the estimated total energy expenditure of Bitcoin miners is 27.78 TWh per year. Or roughly Greece’s entire power bill.
Energy aside, the crypto world is full of scams. Customers can be skeptical and may refuse to deal with a business that is easily targeted by scammers. Even legitimate companies and platforms are infested by scammers. There is a high risk of not getting clients in the long run.
This issue should be addressed by educating and informing stakeholders about your business proposition and corporate governance.
Additionally, government plays a vital role in every business. For people to feel safe with the decisions they are about to make, a regulating body has to be involved in ensuring that the transactions that clients would be making are legal and legitimate. With all these considerations in mind, there are several questions that an ESG report should address.
- What is the environmental impact of Bitcoin mining?
- What sorts of communities and societies are considered and regarded by the organization?
- What ethical, legal, and regulatory standards are followed by the organization?
These are the questions most commonly asked by consumers and skeptics for them to deem the business they are dealing with trustworthy and value-adding not just to them but in our efforts to preserve the rapidly depleting natural resources.
The history of the ESG report.
In order to appreciate the increased demand for ESG reports, it is essential to understand its history. In its most raw form, ESG reports evolved from Socially Responsible Investing (SRI), which dates back several decades.
The ESG report was pioneered during the publication of the report from the United Nations (UN) titled Who Cares Wins, where ESG was initially outlined. It discussed how ESG reports are crucial in making better decisions in terms of business.
There has been a pivotal paradigm shift upon establishing the concepts of ESG in every organization’s financial evaluation. They paved the way for a much more efficient governance structure that helps businesses mitigate risks while keeping them accountable for their environmental and social impacts.
How does ESG reporting work?
The main goal of ESG reports is for companies to retain their long-term value and create a symbiotic relationship with their environments. Hence, it is also called sustainability reports by some sources, and all of the following fall under its purview:
- Climate change.
- Biodiversity.
- Customer relations.
- Global supply chains.
- Data security.
Most established companies are often involved in controversies due to questionable operational practices. The ESG can be seen as a response to said practices.
In essence, companies must put equal priorities between their revenue and their sustainability efforts. Rigorous corporate governance and risk management structures are vital to successfully executing policies and measures addressing environmental and social challenges.
Let’s take a closer look at each
Environment
In this case, a corporation’s effect on matters involving greenhouse gas emissions (GHG), deforestation, solid waste management, pollution, biodiversity, etc., are assessed. Behaviors that negatively affect the above criterion should be reduced when possible.
Society
In this case, we look at specific risks that involve labor & workforce, customer relations, employee relations and wellbeing, community relations, supply chains, human rights, and global relations.
It is a significant consideration for corporations to give utmost importance to their employees as their front liners in dealing with matters between the business and its stakeholders.
Governance
Governance risk is another essential pillar that involves regulatory compliance, compensation & remunerations, fraud, data breach, security, and corruption. When corporations fail to consider these risks, controversies such as employee strikes due to under-compensation can damage the company’s brand.
It is safe to conclude that ESG reports are designed to provide utmost transparency over an organization’s ESG impact on its stakeholders.
Can a company's ESG report follow its own unique criteria?
The ESG reports are annual qualitative and quantitative reports released by companies to showcase their performance for the entire year. ESG reports have their own standards and frameworks. Still, their content varies depending on the business since it reflects how an organization meets its self-defined sustainability goals based on its operations.
Although the defined criteria of every business’s ESG reports may vary, it has to be aligned with the standard frameworks set by the UN.
To better explain this, let us take carbon emissions as an example of an environmental issue. The ESG report comes from a manufacturing company. In that scenario, the company is expected to publish an ESG report to highlight its carbon footprint for the entire year and compare it with its previous years’ performance.
In that scenario, the company is expected to publish an ESG report to highlight its carbon footprint for the entire year and compare it with its previous years’ performance.
Their reports ought to show if there have been changes with the materials they used; if they have optimized the machinery they use to reduce power usage; if they have switched from being entirely dependent on electricity run by fossil fuels; or if they opted to invest in solar panels to power their factory.
The company’s optimal ESG reports will be based on its sustainability goals as influenced by the environmental impact it aims to mitigate. Hence, ESG reports are created not just by the analysts or operations manager but by everyone in the organization as they contribute to the multitude of data which are then organized and transformed into much more sensible infographic reports.
ESG report usage
In a way, ESG reports help organizations to track their sustainability plans and each implementation step. Let’s look at a hypothetical example of a food production company, like Pringles or Lays.
Suppose they aim to switch their packaging material from disposable to sustainable packaging. In that case, their aim may be to redesign their packaging and restructure their outsourcing practices.
- In the first quarter of said transition, they could start looking for new suppliers to find one who is ESG friendly and values sustainability.
- In the second quarter, they may start using the new packaging as they steadily decrease the production of their original product.
- They can ramp production in their third quarter and focus on selling their remaining old product inventory.
- In their fourth quarter, they may start evaluating the cause-and-effect of their transition and what additional steps they can undertake in the future.
As they create their ESG reports, it helps them keep track of their yearly goals and their success rate. It helps measure what adjustments and transitions are needed for the following year.
Establishing a key-point indicator (KPI) from the start helps the ESG reporting team to stay on track with what to look for. Data in ESG reporting should not be manipulated in a way that favors the company. That being said, criteria can be established to specify appropriate targets.
After all, KPIs can vary, especially since not every company belongs to just one industry. In fact, the UN’s goal with “Who Cares Wins” isn’t to create a one-size-fits-all framework for all companies. But instead, it gives a basic set of principles that companies can use to measure their own wins and losses.
Branding risks
Consequently, the good thing about publishing ESG reports is attracting financiers and investors. As you can imagine, investors look for companies with the same values. The common value investors look into is where their money will grow in the long run. You cannot expect an investor to put all their money into your company if they do not see a future for your business.
Having a future for your organization means you can avoid getting involved in controversies that could damage your reputation. ESG reports are in place to help businesses prevent that.
Massive corporations often face controversies, from low-paid workers to massive deforestation and environmental disaster. Few investors would risk putting their assets on businesses that disregard ESG.
Regulatory risks
ESG reports emphasize how a business performs with respect to its environment. It is important to note that companies that violate this aspect can run into serious issues. Potential sanctions are one of the possible ramifications a company may have to deal with if they violate ESG principles.
Regulations, compensations, insurance, and benefits must also be put in place for their workforce whose lives are at stake due to the nature of the job.
Environmental hazards.
ESG reports help create procedures on how a business responds to natural catastrophes and man-made disasters. Recognizing the risks a specific business puts itself through is the first step to identifying what certain measures have to be taken to avoid such hazards. Let’s take mining companies as an example.
It is necessary for them to identify potential risks such as, but not limited to, hazardous chemicals and the possible exposure of their workforce to said dangers. In fact, it is often advised to create a Disaster Risk Reduction and Management team to institute measures to reduce the likelihood of said chemicals leaking into the environment.
On top of it, when a company publishes an ESG report on its official website or through its public relations (PR) material, such as a newsletter or social media, it acts as a powerful communication tool to reach its audiences.
They could either satisfy existing customers or skeptical potential clients. Having an ESG report as a PR communication tool addresses these people’s queries and concerns in order to reduce any probable negative narratives put forth by preconceived notions in the industry to which the business belongs.
For example, fossil fuel companies can commonly face public pushback due to the occasional controversy. For instance, the effects of fossil fuels on climate change, maritime spills contaminating the food supply, leaks into the water supply, etc.
While there are existing agencies, such as the Environmental Protection Agency (EPA), regulating these mining companies, these risks are inevitable. By following ESG principles, companies in this field can mitigate them and improve public opinion.
After all, the general public has become much more well-informed in the past decade, and practices such as cancel culture can affect even the most prominent businesses. Companies want to avoid being on the short end of the stick when the public demands accountability.
Ultimately, ESG reports help set future goals and targets for the organization by providing a framework and standards for conscious consumerism.
Even Small and Mid-size Enterprises (SMEs) have to start integrating the concept of ESG into their business structure because the demand for it is steadily increasing. Businesses that do not have a goal that aims to demonstrate their commitment to building a better society for their business and consumers would eventually face regulatory and legal interventions.
Additionally, ESG-complying businesses may gain local support and build a competitive advantage over time due to the increased trust they foster.
How to prepare an ESG report?
Since ESG reporting must be supported by the data from within the organization, it becomes a responsibility handled by management.
Companies with an established sustainability department can easily adapt to the prerequisites of establishing a team overseeing ESG reports. However, despite said teams, companies sometimes need to make meaningful changes.
In fact, according to a survey done by Accenture, a significant number of executives believe that the most relevant department that ought to be leading the ESG reporting process is the office of the Chief Financial Officer (CFO).
Another survey by Ernst & Young (EY) came up with a conclusion that supported that same claim when they found out that some organizations believe that it is the Finance Team’s primary responsibility to oversee the process of ESG reporting.
The key principle as to why the finance team or CFO is tasked to lead this task is because the people working in this department include analysts and those people who would be capable of extracting a massive amount of data and generating a sensible report.
In terms of data extraction and organization, these are initiated by making sure that the operations directors have been briefed and that they keep track of their daily, monthly, and even quarterly operations. While these data could still be too raw, the ESG team can re-organize it and prune it accordingly to create a detailed and presentable report.
With human resources, data about logistics are often involved. With the supply chain data being pre-organized by the head of human resources, it makes it so much easier for the ESG reporting team to look at how their organization performed regarding its carbon footprint. This makes it easier for the finance team to re-organize the existing data from which a much more sensible report could be generated.
Who should you provide the ESG reports to?
ESG reports are reported to all the stakeholders (investors, potential clients, and even regulating bodies). Contemporarily, ESG reports must be reviewed and rated by rating platforms such as Sustainalytics.
This corporate finance company uses a sophisticated methodology to rate organizations’ ESG Risk Ratings. They measure every business’s reported exposure to ESG risks and how well these organizations manage them.
These ratings are pretty helpful for shareholders. They provide quick feedback on a company’s ability to build a sustainable business and remain competitive in the “green” future.
Furthermore, potential customers might be interested in how companies navigate these risks. To stay up to date, they may check these ratings and other company information sites (news, blogs, etc.).
With that in mind, it is crucial for organizations to publish their ESG reports in a much more digestible way. It’s the perfect opportunity for them to run PR campaigns to showcase their performance to the community locally or internationally.
ESG report limitations
As previously mentioned, ESG reports’ KPIs vary from one company to the other due to industry specificities. Although there are frameworks readily available, these frameworks would also have various underlying factors to consider.
On top of that, as the emergence of ESG reporting becomes much more relevant and in demand, ESG regulations are also evolving. These issues are just complicating the process of ESG reporting in addition to an already complex data management process of ESG per se.
Trying to quantify ESG risks also factors in because the measured risks vary from region to region. For instance, European frameworks may be less applicable to Chinese companies due to regulatory, social, and economic differences.
Consequently, since ESG reports can also be used to improve an organization’s ESG plans and targets, that same target may be irrelevant in the coming years since the maturity of these concepts grows exponentially. With these considerations in mind, ESG reports should be tackled with care and flexibility.
ESG reports for Chinese companies
In the past decade, despite its massive reliance on fossil fuels, China has steadily increased its investments in sustainable energy to create a green economy, becoming carbon neutral by 2060.
And they don’t stop their plans with their environment. The government has taken big steps to reduce the nation’s rampant economic inequality. In this context, ESG reports became extremely important.
In fact, in 2016, the People’s Bank of China (the Chinese central bank) and the China Security Regulatory Commission (CSRC) laid Guiding Opinions on Building a Green Finance System, which is essentially a mandate for an environmental information disclosure system.
As a result, in 2018, the CSRC revisited and revised the Listed Company Governance Code and implemented an amendment that included the responsibility of listed companies to disclose ESG information.
The Asset Management Association of China (AMAC) issued the first Green Investment Guide (Trial) and the Research Report on ESG Evaluation System for Chinese Listed Companies (2018), which aims to guide investors to delve into green investment activities and advocating listed companies to refine and enhance information disclosure and corporate governance.
In 2020, Chinese President Xi Jinping emphasized the nation’s intention to become carbon neutral by 2060. Further reforms and revisions to an existing regulation were made to better govern companies as they all mitigate their carbon footprint by transitioning to a much greener economy.
In conclusion, it is often best to work alongside regulatory forces to remain profitable in the modern economic landscape rather than against them. Leveraging the ESG report can be a significant step to showcase commitment towards the stated national goal and attract investors and governmental subsidies.
